The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Thursday, June 14, 2012

Having seen enough of the Japanese model, Germany's Merkel calls for the Swedish model to handle bank solvency led financial crisis

As reported in the Telegraph, Germany's Angela Merkel has seen enough of the Japanese model and its failed policies to call for a new direction. The new direction she appears headed towards is the Swedish model with ultra transparency.

Germany cannot save the euro single-handedly, Angela Merkel has warned, expressing her growing anger over British, American and G20 demands that she does more to tackle the eurozone debt crisis....

"All eyes are on Germany," she told German MPs on Thursday. "But we also know that Germany's power is not infinite. So our responsibility as Europe's largest economy is to deploy our strength credibly." ...

Under your humble blogger's blueprint for saving the financial system, sovereign debt capacity is saved to support economic growth.

A Spanish bank bailout, using EU funds, of up to €100bn to rescue its banks was announced last weekend in a bid to insulate the eurozone against financial contagion from the political chaos that is expected to follow the Greek vote.

But markets have rejected the Spanish bailout, pushing the cost of Spanish borrowing to euro-era highs and threatening to take the EU single currency's debt crisis into a dangerous new phase.

Germany regards the Spanish bailout as being too late, after Spain resisted strict German conditions on the loan for months, and as another ill thought out "quick fix" that has made the eurozone's crisis even worse.

As I predicted, the bailout would not work and it would make the situation worse.

First, it was needless. Spain's banks could retain future earnings to recapitalize themselves.

Second, it diverted resources that were needed to support economic growth to what is effectively paying bankers' bonuses. Never a good policy choice.

Mrs Merkel is personally angry after being assured by the European Central Bank that massive "LTRO" liquidity operations early this year, cheap bank loans worth over €1 trillion, would prevent a new banking crisis for three years.

"She was reluctantly convinced that the effect of the liquidity operations would last for years but it lasted six months before being absorbed into failed or failing banks," said a senior European official.

Liquidity does not end a solvency crisis. As the Bank of England's Mervyn King said, EU banks must recognize their losses.

German finance officials note that since 2010 various eurozone counter crisis measures - including LTRO and bailouts - have seen "risk mutualisation" of €2 trillion in debt, with Germany liable for the lion's share.

The German government was aghast last month when PIMCO, a leading investment house, announced that it had stopped buying Germany's sovereign bonds because it was concerned over the burden of its eurozone obligations.

Under the Japanese model for handling a bank solvency led financial crisis, bank capital levels are protected. This leads to policies like the LTRO and bailouts. Just like in the US and UK, the bankers privatized the gains and socialized the losses. In Germany's case, it appears that it socialized the losses from across the EU.

Mrs Merkel has flatly ruled out calls by Francois Hollande, the French President and Mario Monti, the Italian Prime Minister, for Germany to underwrite joint euro-area debt.

"All resources, all measures, all packages will end up being smoke and mirrors if it becomes clear in the end that they extend beyond Germany's capacity," she said....

"It's our obligation today to do what has been neglected, to break the vicious circle of generating ever more debt and breaking the rules," said Mrs Merkel.

The only way to achieve this is to adopt the Swedish model with ultra transparency. Rather than generate more debt, the Swedish model actually reduces the total amount of debt outstanding. It does this by having the banks recognize the losses on all the debt in excess of the borrower's capacity to repay in the financial system.

Subsequently, without using government funds, the banks rebuild their book capital levels through retention of 100% of pre-banker bonus earnings.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.